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Interest Rate Structure

Interest Rate Structure

The bond market is a large financial market. and has an impact on the economic system Business entrepreneurs and investors One of the factors that determine the price of a bond is the interest rate.

Factors that affect interest rates include:

• Debt Issuer Risk The risk of an issuer is assessed by credit rating agencies.
• Debt liquidity risk Short-dated debt instruments have higher trading liquidity than long-dated debt instruments. As a result, interest rates on short-term debt instruments are lower than on long-term debt instruments.
• Remaining life of debt instruments
• Special provisions on debt instruments

Debt return structure

Yield = Risk free + default premium + liquidity premium + special provisions

Yield is the rate of return from holding debt instruments.

Risk-free is the rate of return without risk. It is mainly determined by the government bond yield.

The default premium is the compensation for the debt issuer’s risk (credit risk).

Liquidity premium is compensation for liquidity risk.

Relationship between interest rates and inflation

The concept of the Fisher Effect explains the relationship between interest rates and inflation. The relationship is as follows:

Normal risk-free rate = Real risk-free rate + Inflation premium

An example can be given as follows:

As of January 30, the one-year Treasury yield was 1.5% while inflation was 0.8%. Therefore, the normal risk free rate of bond yields is

1.5% = Real risk free rate + 0.8%

1.5% – 0.8% = 0.7%